Charlie Munger On Leverage and Paying Your Mortgage Off Before Retirement

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housemoneyWhile reading back through various transcript notes from the 2015 Berkshire Hathaway Annual Meeting, I recalled the following quote from the Q&A session. A shareholder had asked why Berkshire had never borrowed money to buy stocks (i.e. leverage). Charlie Munger replied:

It’s obviously true. If we’d used the leverage that some others did, Berkshire would have been much bigger … but we would have been sweating at night. And it’s crazy to sweat at night.

This is an important point, as many other similar investors have used leverage to boost their returns (not always, but some with success). Buffett and Munger certainly could have justified such an action, especially given their excellent investment track record.

Munger did not make this jump, but I believe but an individual investor could also apply this quote to paying off their mortgage early. Even I enjoy discussing the details of mortgage payoff vs. retirement savings, and acknowledge that mortgage interest rates are low while stock returns are historically higher. Why use your money to pay off your mortgage when you could invest in stocks instead?

The problem is that if you are putting off paying off your mortgage just so you can invest in stocks, you are using leverage! That is, you are taking borrowed money and then putting it at risk. That may increase your overall returns, but it will also increase your exposure to bad outcomes. For most people – not everyone, but most – paying off your mortgage debt will help you sleep better at night. Based on his biography, Warren Buffett himself bought a house in cash when he got married. Even though he was confident he would have made more money by putting those funds toward his investment partnership, he chose not to have a mortgage.

In addition, many financial advisors are incentivized to maximize the amount of your money that they manage, as they can’t earn any fees off your home equity. Wes Moss, a fee-only advisor and Money Matters radio show host, ignores that and gives blunt advice in his book You Can Retire Sooner Than You Think:

Sooner or later, every homeowner asks the simple question, “Should I pay off my mortgage?” and immediately gets bombarded with a variety of complicated, hedged responses. Here is the simplest possible answer: Yes. If you are anywhere near retirement and can afford to pay off your mortgage, you should.

I view this as an example of how real-world, experience-based advice can differ from theoretical, academic-based advice. Humans are not perfectly rational. I have never regretted paying off my mortgage early, although I do agree with the qualification that mortgage payoff should roughly coincide with retirement date.

* Of course, Warren Buffett quickly added: “…over financial things.” Ba-dum-bum-ching!

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  1. For most investors this is excellent advice, however for those in the Real Estate field of investing the answer is more complicated. In my case I have 39 mortgages including my residence, total of 47 properties, (mostly single family and small multi-units), I logically choose to pay down the highest interest rate loans first when I have extra funds, my residence has a rate of 3.5% while my highest rate rental home has a 7% loan, I benefit twice as much paying off 7% debt….
    I would generally agree with this advice with the qualification that a prudent investor should pay off the highest rate debt first.

  2. The real question is your view of the market (S&P500). If you think it is topping here and will not go much higher, then you should NOT put any new money into it and instead pay off your mortgage. So if you think S&P500 will offer you 0% or even negative return in the next couple of years, then put your money into your mortgage where you will get guaranteed 4% (depends on your mortgage rate). It’s simple mathematics. And that’s what I am going to do over the next couple of years. Then once the mortgage is paid off, I will be buying S&P500 again. Probably cheaper than at 2120 (all time high today).

    • I think tying your investment decisions to the short-term predictions of the stock market levels is an unreasonable strategy. What makes you think you can predict S&P performance better than other market participants?

    • birdsnbats says

      Do not embrace this sort of avoidance phenomenon if you want to maximize your long term returns. Being able to time when to get out and when to get back in market is a fools game.

      Many investors are still on the the sidelines since 2008 waiting for a “crash” and paying down 3% mortgages while still having 20 plus years in the workforce and sticking money in 1% money markets. Overall, this is a backwards financial plan.

  3. I would like to share my thoughts and experience on this subject. I am 66 and have paid off the mortgages on two homes. I paid off the first in my early forties. My incentive was that my mortgage was 9%. I had the habit of saving to my 401k and putting extra cash into mutual funds every month. I only bought stock funds when I invested. My portfolio was in no way balanced. I stopped investing part of the cash into mutual funds and directed the cash to paying off the mortgage. In my opinion this was a way of balancing my portfolio and it also gave me a feeling of security. A few years before I started paying the mortgage off I had lost my job. Although, I was not actually out of a pay check for my short period of unemployment, it made me realize that things can change quickly and having no mortgage when the cash stops flowing is very desirable.

    In the late 1990s, I was relocated and purchased a new home. While the relocation has been great, you are faced with a lot of uncertainties at the beginning. So, to keep plenty of cash on hand, I took out a mortgage. The interest rate was over 7%. Once the old house was sold, I paid down the mortgage with the proceeds from the sale, but that still left me short because we had purchase a more expensive home. The stock market had been going up into the late 1990’s, so I sold off some mutual funds and paid off the mortgage on the second house. I had liked the feeling of not having a mortgage in the past and I wanted that security again. It also gave me an opportunity to balance my portfolio again. When the market tanked, I felt very smart. I was just lucky, but there was value in balancing the portfolio. I continued for years only investing in stock funds, and my home was my only other major asset. My portfolio became very unbalanced, but I enjoyed the value of dollar cost averaging during those two major stock market declines.
    For me paying off my mortgages has worked well. As I said, I put a lot of value in the security of not having a mortgage. The increased cash flow from no mortgage has been great. I was fortunate to invest the extra cash during a great time for dollar cost averaging. It also let me pay for my kids college education without anyone needing to go into debt.

    Home interest rates were high when I made my decisions, so I think it was easier to decide than it is today when mortgage rates are so low. I have even been tempted to take out a mortgage again because the rates are so low, but I don’t want to give up that extra cash flow and the feeling of security of having no mortgage. Also, I have enough, because I save and have never had credit card debt and only had an auto loan when the rates were so low that it did not make since to pay cash.

    I wish I had had a resource like this blog when I was making financial decision when I was younger. Good luck to all you young people who are out gathering good financial information.

  4. After what some family members have had to go through I would never advise anyone to stall their mortgage payments to invest money somewhere else. If you have extra funds available, do as much as you can to pay down your debt, so like the article said, you can sleep at peace at night. Having debt on the side and investing in a variety of places is never a good option as debt has a bad habit of catching up to you.

  5. Just advised my mother-in-law pay off her mortgage on her so cal home. She didn’t realize she had a 5.5% loan and only owed about 30k. We showed her the math v. her retirement, savings, income. Pretty clear and big ROI for her. Plus now she has various sources of income and not a single bit of debt anywhere. That’s pretty sweet. And because she’s in CA, her property insurance will climb very slowly.

    We’re in a different place and while we pay extra each month, we don’t drop thousands in each month. I’d rather play the market for bigger gains. And yes it’s play. The mortgage is set at 4%. My wife’s salary can cover. Which means we can dump cash like crazy in the house for a 4% return (not including write-offs) or maybe get more ETFs, stocks, etc and shoot for 10% or more.

  6. US government and federal deserve actively discourage saving/ paying off debt.

    If I had leveraged up in last 5 years, my net worth would have been double by now.

    • That’s what big businesses have been doing for the last 7 years. They take low interest loans at near zero percent, buy their stock back and watch their stock prices go through the roof.

  7. I find it interesting the way many commenters believe that there is a right, or wrong way to spend (invest) their money.

    There are ways that historically have returned more than others, but citing this only shows that you don’t understand that history is only a good measure of risk, not return.

    @Jonathan – Great article. When you have debt, every dollar you spend is borrowed money.

    But debt has been a great accelerator so far and so I’m not saying that being debt free should be your number 1 priority, however I believe the security that it brings will make it a priority for most people at some point in their lives.

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